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Small Stocks: Big Profits or Big Problems?

Chris Lahiji wants to take Wall Street’s bull by the horns and turn it into flank steak. The motor-mouthed 19-year-old Los Angeles resident’s goal is to become the youngest mutual fund manager ever.

“All institutions want me to fail,” he claims. “I mean, how bad would it look if a 19-year-old kid beats their a–?”

What is Lahiji’s idea of a sound investment? Ultra high-risk penny stocks – companies whose shares trade at $5 and below, usually for good reason. Typically, but not always, if a stock sits in the cheap seats, either the company is struggling or is on the verge of bankruptcy.

But to Lahiji, penny-stock land might as well be Candyland, as he claims his investments have earned 136 percent over the past several months. Lajihi insists he screens out more than 6,000 stocks to find the right investment. His portfolio recommendations have included baker Montana Mills, financial website Hoover’s, and lottery ticket maker GTech.

He brags that he has a loyal following on his financial website Lahiji.com. According to Lahiji, his picks are so popular that he has the rare ability to move markets on his recommendations.

“I buy stocks that people can relate to – companies that make materials for wedding gowns and chips for sound systems,” Lahiji explains.

While that may all sound exciting, financial experts warn against investing in the far reaches of the stock market — especially penny stocks — right off the bat.

“Only 1 percent of the people who invest in penny stocks make a fortune and most lose a fortune,” cautions Fred Siegel, president and portfolio manager of Siegel Group, Inc., host of Talking Money on WWL-AM in New Orleans, and author of the book 401(k)s for Cowards. “Even if you make money investing in penny stocks, if you do it for too long, you’ll eventually lose everything you make. It’s essentially gambling.”

Siegel advises young people to focus on getting out of debt first by paying off their credit cards. If there is money leftover, he suggests investing in what he likes to call “chicken stocks.” These are shares of companies with a track record of higher profits every year for 12 years and that have increased their dividends for 12 years in a row. Examples include insurer AFLAC, retail giant Wal-Mart, medical stalwart Johnson & Johnson, food supplier Sysco Foods, and medical supply company Stryker Corp.

Siegel and Hugh McNaughton, investment representative for Edward Jones in Santa Ana, Calif., both advise not jumping into penny stocks, as Lahiji recommends. “You can’t win that game in the long run,” McNaughton warns. “Don’t put all your money on the roulette wheel on red, and definitely don’t put all your money in penny stocks…; 90 percent of all small businesses fail.”

If you want to take a flyer on penny stocks, McNaughton recommends that you put a small percentage of your money in a small cap mutual fund to spread the risk between thousands of companies, as opposed to one or two shots in the dark. He also recommends that no matter what the investment, whether large cap growth stocks, such as software guru Microsoft, or mid-cap players, such as filmmaker Pixar, you “dollar-cost average” into the stock or fund. Dollar-cost averaging is an investment strategy where a person invests consistent amounts of money at regular intervals.

Basically, you set aside a certain amount of money into the fund each month, say $50, and have it automatically deducted from your bank account, so it doesn’t touch your hands. The advantage is that you buy more shares in down markets and less shares in up markets, using the power of compounding your money to your advantage.

Meanwhile, once you get your first job, be sure to set aside at least the company match in a 401(k) retirement plan. Most companies will match a percentage of your retirement contributions. It’s free money, it’s sound investing, and it’s a great way to lower your tax bite.

That’s the tried-and-true way of making wealth slowly. Of course, Lahiji would likely find these methods to be too old school for his new age style. “Small company investing is the way to go,” Lahiji counters. “You’re helping the economy grow from the bottom up.”